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Source: When Fast Growing Economies Slow Down: International Evidence and Implications for China

Within the next five years, the United States is
expected to experience a manufacturing renaissance with a return of the 'Made in
USA' badge, as the wage gap with China shrinks and certain US states become some
of the cheapest locations for manufacturing in the developed world, according to
a new analysis by the Boston Consulting Group (BCG). Meanwhile, a recently
published economics paper says that some of the strongly growing emerging
economic powers such as China and Brazil, could face a middle-income trap where
growth slows.

Lawrence Summers, Harvard economist and President
Obama's former economic adviser, famously said: "The dramatic modernization
of the Asian economies ranks alongside the Renaissance and the Industrial
Revolution as one of the most important developments in economic history."
There is no need for revisionism on the judgment but with the great leap
forward, BCG says as Chinese wages are rising at about 17% per year and the
value of the yuan continuing to increase, the gap between US and Chinese wages
is narrowing rapidly. Meanwhile, flexible work rules and a host of government
incentives are making many US states - - including Mississippi, South Carolina,
and Alabama - - increasingly competitive as low-cost bases for supplying the US
market.

“All over China, wages are climbing at
15 to 20% a year because of the supply-and-demand imbalance for skilled labor,”
said Harold L. Sirkin, a BCG senior partner. “We expect net labor costs for manufacturing in China and the
US to converge by around 2015. As a result of the changing economics, you’re
going to see a lot more products ‘Made in the USA’ in the next five years.”

After adjustments are made to account for
American workers’ relatively higher productivity, wage rates in Chinese cities
such as Shanghai and Tianjin are expected to be about only 30% cheaper than
rates in low-cost US states. And since wage rates account for 20 to 30% of a
product’s total cost, manufacturing in China will be only 10 to 15% cheaper than
in the US - - even before inventory and shipping costs are considered.
After those costs are factored in, the total cost advantage will drop to single
digits or be erased entirely, Sirkin said.

Products that require less labour and are churned
out in modest volumes, such as household appliances and construction equipment,
are most likely to shift to US production. Goods that are labour-intensive and
produced in high volumes, such as textiles, apparel, and TVs, will likely
continue to be made overseas.

“Executives who are planning a new
factory in China to make exports for sale in the US should take a hard look at
the total costs. They’re increasingly likely to get a good wage deal and
substantial incentives in the US, so the cost advantage of China might not be
large enough to bother - - and that’s before taking into account the added
expense, time, and complexity of logistics,” said
Sirkin, whose most recent book, GLOBALITY: Competing with Everyone from
Everywhere for Everything, deals with globalization and emerging markets.

BCG says a number of companies, especially
US-based ones, are already rethinking their production locations and supply
chains for goods destined to be sold in the US. For some, the economics have
already reached a tipping point.

Caterpillar, for example, announced last year the
expansion of its US operations with the construction of a new
600,000-square-foot hydraulic excavator manufacturing facility in Victoria,
Texas. Once fully operational, the plant is expected to employ more than 500
people and will triple the company's US-based excavator capacity. “Victoria’s
proximity to our supply base, access to ports and other transportation, as well
as the positive business climate in Texas made this the ideal site for this
project,” said Gary Stampanato, a Caterpillar vice president.

NCR Corp. announced in late 2009 that it was
bringing back production of its ATMs to Columbus, Georgia, in order to decrease
the time to market, increase internal collaboration, and lower operating costs.
And toy manufacturer Wham-O Inc. last year returned 50% of its Frisbee
production and its Hula Hoop production from China and Mexico to the US

“Workers and unions are more willing to
accept concessions to bring jobs back to the US,”
noted Michael Zinser, a BCG partner who leads the firm’s manufacturing work in
the Americas. “Support from state and local governments
can tip the balance.”

Zinser noted that executives should not
make the mistake of comparing the average labor costs for production workers in
China and the US when making investment decisions. The
costs of Chinese workers are still much cheaper, on average, than comparable US
workers, and some managers may assume that China is a better location. But
averages can be deceiving.

“If you’re just comparing average wages
in China against those in the United States, you’re looking at the problem in
the wrong way,” Zinser cautioned. “Average wages don’t reflect the real decisions that companies
have to make. Averages are historical and based on the country as a whole, not
on where you would go today.”

“In the US, we have highly skilled workers in
many of our lower-cost states. By contrast, in the lower-cost regions in China
it’s actually very hard to find the skilled workers you need to run an effective
plant,” added Doug Hohner, another BCG partner who focuses on manufacturing.

BCG says even as companies reduce their
investment in China to make goods for sale in the US, it is clear that China
will remain a large and important manufacturing location. First, investments to
supply the huge domestic market in that nation will continue. Second, in the
absence of trade barriers that prevent offshoring, Western Europe will continue
to rely on China’s relatively lower labor rates since the region lacks the
flexibility in wages and benefits that the US enjoys.

Third, even though other low-cost countries - -
such as Vietnam, Thailand, and Indonesia - - will benefit from companies seeking
wage rates that are lower than China’s, only a portion of the demand for
manufacturing will shift from China. Smaller low-cost countries simply lack the
supply chain, infrastructure, and labour skills to absorb all of it, Hohner
noted.

The Middle Income Trap

It is sometimes said that China will become old
before it becomes rich

China's census results show that the world's
second-biggest economy is moving towards a demographic watershed that will
trigger wage rises, higher inflation and lower growth, a Chinese economist said
in comments published last week.

Ba Shusong, a senior economist at the State Council Development Research Center,
said the 2010 census data issued in April, together with other data, showed
China's supply of abundant cheap labour would start shrinking soon.

"The current data show China has already crossed the Lewis turning point, and
at the same time the window of the demographic dividend will soon close," Ba
wrote in the Economic Information Daily.

A United Nations' agency
report on global population, published last week, said that China, which has
a one-child policy could see its population peaking at 1.4bn in the next couple
of decades, then declining to 941m by 2100.

A working
paper (pdf)
produced by Barry Eichengreen, a professor of economics at the University of
California, Berkeley, Donghyun Park, an economist at the Asian Development Bank
and Kwanho Shin, an economist at Korea University, Seoul, say that periods of
high growth in late-developing economies do not last forever. Eventually the
pool of underemployed rural labor is drained. The share of employment in
manufacturing peaks, and growth comes to depend more heavily on the more
difficult process of raising productivity in the service sector. A larger
capital stock means more depreciation, requiring more saving to make this good.
As the economy approaches the technological frontier, it must transition from
relying on imported technology to indigenous innovation.

The economists add: "Using international data starting in 1957, we construct a sample
of cases where fast-growing economies slow down. The evidence suggests that
rapidly growing economies slow down significantly, in the sense that the growth
rate downshifts by at least 2 percentage points, when their per capita incomes
reach around $17,000 US in year-2005 constant international prices, a level that
China should achieve by or soon after 2015. Among our more provocative findings
is that growth slowdowns are more likely in countries that maintain undervalued
real exchange rates."

On the impact of undervalued currencies,
the authors say: "it may be that countries that rely on
undervalued exchange rates to boost economic growth are more vulnerable to
external shocks resulting in sustained slowdowns. It may be that real
undervaluation works as a mechanism for boosting growth during the early stages
of development when a country relies on shifting labor from agriculture to
export-oriented manufacturing but not in subsequent stages when growth becomes
more innovation intensive, but governments are reluctant to abandon the earlier
policy strategy, leaving the economy increasingly susceptible to slowing down.
It could be that real undervaluation allows imbalances and excesses in
export-oriented manufacturing build up, as in Korea in the 1990s, through that
channel making a sustained deterioration in subsequent growth performance more
likely."

The economists also found that higher dependency
ratios increase the likelihood of a growth slowdown. And they suggest that the
data indicate that China is likely to face just such a slowdown within the next
ten years.